About Retirement Portfolio Strategy

The first rule of retirement income planning is: Never run out of cash. The second rule is: always remember the primary rule.

It sounds pretty straightforward. Where it gets complicated is negotiating between two equally valid but conflicting concerns: the necessity for safety and capital preservation, and therefore the need for growth to hedge inflation over the lifetime of the retiree. Few people want to require high-flying risks with their retirement funds, but a zero-risk investment portfolio—one invested solely in safe income vehicles, like Treasury bonds—will steadily erode the worth of the nest egg, even with very modest withdrawals. Counterintuitive because it sounds, it’s about guaranteed that zero-risk portfolios won’t meet any reasonable economic goals. On the opposite hand, an equity-only portfolio has high expected returns but comes with volatility that risks decimation if withdrawals continue during down markets.

The proper strategy balances these two conflicting requirements.

Balanced Portfolio

The goal are going to be style a portfolio that balances the wants of liberal income with sufficient liquidity to face up to down markets. We will start by dividing the portfolio into two parts with specific goals for each:

1. The widest possible diversification reduces the volatility of the equity portion to its lowest practical limit while providing the long-term growth necessary to hedge inflation, and meets the entire return necessary to fund withdrawals.
2. The role of fixed income is to supply a store useful to fund distributions and to mitigate the entire portfolio volatility. The fixed income portfolio is meant to be near market volatility instead of plan to stretch for yield by increasing the duration or lowering credit quality. Income production isn’t a primary goal.

Both portions of the portfolio contribute to the goal of generating a liberal sustainable withdrawal over long periods of your time. Notice that we are specifically not investing for income; rather, we are investing for total return.

Total Return vs. Income

Your grandparents invested for income and crammed their portfolios filled with dividend stocks, preferred stock, convertible bonds, and more generic bonds. The mantra was to measure off the income and never touch the principal. They chose individual securities supported their big fat juicy yields. It seems like an inexpensive strategy, but all they got was a portfolio with lower returns and better risk than necessary.

At the time, nobody knew better, so we will forgive them. They did the simplest they might under the prevailing wisdom. Besides, dividends and interest were much higher in your grandparents’ time than they’re today—and life expectancies after retirement were shorter. So, while faraway from perfect, the strategy worked after a fashion.

Today, there’s a much better thanks to believe investing. The whole thrust of recent financial theory is to vary the main target from individual securities selection to asset allocation and portfolio construction and to consider total return instead of income. If the portfolio must make distributions for any reason, like to support your lifestyle during retirement, it’s possible to select and choose among the asset classes to shave off shares as appropriate.

Rebalancing the Portfolio

Rebalancing within equity classes will incrementally enhance performance over the future by enforcing a discipline of selling high and buying low as performance among the classes varies.

Rebalancing involves watching the worth of assets in your portfolio—stocks, bonds, etc.—and selling people who have exceeded the share allocated to them once you first structured your portfolio.

Some risk-averse investors may choose to not rebalance between stocks and bonds during down equity markets if they like to stay their safe assets intact. While this protects future distributions within the event of a protracted down equity market, it comes at the worth of opportunity costs. However, we recognize that sleeping well may be a legitimate concern. Investors will need to determine their preferences for rebalancing between safe and risky assets as a part of their investment strategy.